Price as Productivity

In Public sector, UK productivity, Uncategorized on November 22, 2010 by Tim Aikens

The pressure is on as never before to cut cost.  Hopefully most of us naturally think of improving productivity. But many organisations try to take a simpler and faster route – persuading their suppliers to cut prices!  The government has taken a significant role in this. The Efficiency and Reform Group (ERG) run by Francis Maude MP started earlier this year by asking Tier 1 suppliers (like SERCO) not only to cut rates, but also to provide rebates on past work!  ERG is now doing the same with Tier 2 suppliers – including many engineering companies.  In the private sector supermarkets are good at pressing suppliers to cut costs.  So the question is, is this a good thing?

Well, yes and no.  There is no doubt that productivity has to rise if this country is to earn its way out of debt. Increases in productivity allow prices to fall without cutting margins, so that is the good news. But simply asking a supplier to cut the price (often within an existing contract) is simply taking a short cut and is, in my view, an abuse of economic power.  It is a form of economic blackmail.  The other major problem from the government perspective is that the attack is on unit rates (usually for labour) rather than the overall cost or price paid.  One way a professional services business can cut cost is to hire less able people at lower salaries. Their hire out rate can be reduced, but often they need more hours to complete a particular job. The end result is an overall higher cost even though the unit rate is lower. So cutting price does not always work.

Maude and the ERG obviously want jam today – as well as tomorrow, so how else can he go about this?

What he should be doing is looking at how government is using these suppliers.  I would make a small wager that there is already a huge amount of waste in what is actually supplied. ERG would save more by sensibly reviewing the services and making sure that they only buy what is needed.  In the engineering world one of the major causes of cost increase is that the client (in this case government) keeps on changing their mind about what they want. This causes rework that has to be paid for and pushes up the cost.  So government and others need to look at how they use their suppliers rather than turning the screw on price.  There is another good reason for doing this.  At present we are in (or at best coming out of) a recession.  Businesses are more flexible and need all the work they can get.  They will slash prices to ‘buy’ the work  if  it keeps the business afloat.  However, once things look up, business will pick up and so will rates.  Government and other buyers will have to pay higher rates and costs will rise.  There have been no productivity gains only fairly short lived price cuts.

If you want lasting cost reduction you need real productivity increase not just a quick fix cut in unit labour rates!  Get price reductions from sensible, competitive procurement, not bullying your suppliers!


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